Cost and Profit Centers: Classification and Costing Methods

Posted on Nov 26, 2024 in Economy

Cost and Profit Centers

Definitions

A profit centre is a business segment responsible for both revenue and expenses, disclosing the profit of a particular activity. Profit centres are created to delegate responsibility to individuals and measure their performance.

A cost centre is the smallest unit of activity or area of responsibility for which costs are collected. Cost centres are created for accounting convenience and cost control.

Key Differences

  • Responsibility: Profit centres are responsible for both revenue and expenses, while cost centres are only responsible for costs.
  • Autonomy: Profit centres are autonomous, while cost centres are not.
  • Targets: Profit centres have profit targets, while cost centres aim to minimize costs.
  • Structure: A profit centre may contain multiple cost centres, representing different activities within the profit centre.

Cost Classification Methods

  1. By Nature or Elements: Materials (raw materials, components, etc.), Labour, and Expenses.
  2. By Functions: Production costs (manufacturing, construction) and Commercial costs (administration, selling, and distribution).
  3. By Degree of Traceability: Direct costs (easily traced to a product) and Indirect costs (benefit multiple products).
  4. By Changes in Activity or Volume: Fixed costs (remain constant in total), Variable costs (vary with output), and Semi-variable costs (partly fixed, partly variable).
  5. Association with the Product: Product costs (traceable to the product) and Period costs (incurred over time).
  6. By Controllability: Controllable costs (can be influenced by a specific individual) and Non-controllable costs.
  7. By Normality: Normal costs (typically incurred) and Abnormal costs (incurred under unusual circumstances).
  8. By Relationship with Accounting Period: Capital costs (incurred for long-term assets) and Revenue expenses (incurred for ongoing operations).
  9. By Time: Historical costs (recorded after being incurred) and Predetermined costs (estimated in advance).

Principal Costing Methods

  1. Job Costing: Costs are ascertained for specific, non-comparable jobs (e.g., printing, auto repair). Includes:
    • Contract Costing (large-scale contracts)
    • Batch Costing (similar products treated as one job)
    • Terminal Costing (cost terminated at a specific point)
    • Operation Costing (cost of a specific operation)
  2. Process Costing: Costs are tracked through distinct production stages (e.g., textiles, chemicals).
  3. Unit Costing: Cost per unit is calculated for continuous manufacturing of a single product (e.g., bricks, cement).
  4. Operating Costing: Cost per unit of service is calculated (e.g., transport, utilities).
  5. Multiple Costing: Combines different costing methods for complex products (e.g., cars, airplanes).
  6. Uniform Costing: A common costing system used within an industry for comparison.
  7. Departmental Costing: Costs are ascertained department by department.

Costing Terms

  1. Direct Materials: Easily identifiable and measurable materials directly used in the product.
  2. Indirect Materials: Materials that cannot be directly traced to the product (e.g., consumables).
  3. Direct Labour: Labour directly involved in altering the product.
  4. Direct Expenses: Expenses directly attributable to a specific cost centre.
  5. Overheads: Indirect costs, including indirect materials, labour, and other expenses (manufacturing, administration, selling, distribution, R&D).